Financing Retail Installment Transactions
The larger, more expensive the item, the less likely the consumer
is to use a credit card for the purchase. The item is often purchased
using an installment credit plan with regular, fixed monthly
payments over several months or years.
The retailer can make the loan to the consumer directly – “carry
the paper in-house.” More likely the retailer will seek indirect
financing of the purchase, selling the installment paper to a
commercial bank or finance company after the sale or having the
consumer deal with the bank or finance company before the sale is
Carrying the installment paper themselves means retailers have to
raise more funds to finance the accounts receivable.
Commercial Bank Financing
Banks can simply make loan commitments directly with
consumers. The bank has much greater control over the credit
process, gets to know the customer well before extending credit,
and can broaden and control the type and volume of installment
business in its trading area.
But loan business generated this way is much less important than
the indirect method, walk-in business is usually low, and
repossession is usually more difficult than when a dealer is
Also called the dealer method. This method is much more
prevalent than the direct method.
A dealer takes the credit application in association with the sale of
some item. The bank approves (or disapproves) the application
and gives the money to the dealer. The customer than pays the
bank the monthly payments.
• Bank has no chance to get to know the customer personally.
• Indirect borrowers are often less conscientious toward
payments on the loans than are direct borrowers.
• Fraud and misrepresentation are easier for the borrower if the
bank doesn’t see the borrower personally.
• The dealers can be far less interested in the creditworthiness
of customers than the bank will be.
Banks like indirect installment credit despite the possible
problems because a high volume of loans can be generated easily.
Banks consider the dealers’ financial and business history as well
as their reputation and character. The most profitable relationship
for the bank will be one with a dealer who is also trustworthy and
makes credit sales to creditworthy customers.
Banks consider the following when looking at dealers:
• Current and past financial statements
• Deposit relations with the bank
• Trade references
• Distributor or manufacturer relations
• Credit reports from credit reporting agencies
• Experience of other financial institutions with dealers
• Reputation at Better Business Bureau
Bank polices in relationship with dealers:
• Bank must be able to make quick decisions on loans dealers
originate with customers
• Bank personnel must thoroughly understand dealers’ selling
and credit problems
• Bank must have effective collection policy
• Bank must adopt competitive loan terms
• Bank may provide inventory financing to dealers
• Bank must have effective account monitoring procedures
• Bank should extend other banking services to dealers
Financing Plans Available to Dealers
Full Recourse. Dealer guarantees the loan. If the borrower
defaults, the dealer must come up with the balance due.
Dealer has responsibility for handling any collateral. But
dealer gets a lower discount rate. (Dealers don’t get the full
amount of the loan when the bank finances the sale.)
Nonrecourse. The bank assumes the risk of default and
handling any repossession.
Repurchase. Dealer has to buy back the product for the
unpaid balance. Bank has to do the repossessing first.
A dealer reserve is an account at a bank maintained as an
agreement between the bank and the dealer to help protect the
bank and dealer against the dealer’s contingent liability (assuming
the dealer still has some responsibility for the paper bought by the
bank). The bank charges customers a higher rate than it would
charge the dealer. The difference can be put into the dealer reserve
account in case of borrower’s default and dealer’s liability being
activated. The dealer reserve can be used by the dealer to help
satisfy some of the new liability.
Commercial banks finance inventory of retail dealers. Also known
as flooring, floor planning or wholesale floor plan. It is common
in auto dealerships. Bank loans money to dealers so they can buy
cars and the loan is paid off as the cars are sold. The bank also
probably finances the car purchase by the customer.
Sales Finance Companies
Sales finance companies perform the same services for dealers that
commercial banks do but the sales finance company specializes in
just sales finance. They do not loan directly to consumers. Sales
finance companies may be subsidiaries of other companies:
Sales finance companies are common in auto loans but also deal in
boats, aircraft, manufactured homes, farm machinery, etc.
Dealers and banks often create long-term relationships with each
Competition between financial institutions for installment
contracts is intense.
Approval of loans to customers by banks and sales finance
companies can be very rapid. Competition keeps the financial
institutions continually improving their services.
Computers can make approvals almost instantly with links to
appropriate credit rating services. A rejected application can be
looked at by a human for a second chance.